Return on Expectations
The first step is, of course, agreeing on a definition. What do we mean when we say âinvestor relations and financial communicationâ? Many investor relations professionals, undeniably, will point to a definition of investor relations adopted by the National Investor Relations Institute's (NIRI) Board of Directors in March 2003: âa strategic management responsibility that integrates finance, communication, marketing and securities law compliance to enable the most effective two-way communication between a company, the financial community, and other constituencies, which ultimately contributes to a company's securities achieving fair valuationâ (cited in NIRI Board of Directors, n.d.).
Other practitioners of financial communication may suggest that investors are just one of many types of publics that corporations need to communicate with; these practitioners point to a wider definition: âa strategic communication process that builds mutually beneficial relationships between organizations and their publicsâ (Public Relations Society of America [PRSA], 2016). Here, of course, the word âpublicsâ is used generically and can be replaced with a specific public depending on the functionâfor example, for investor relations, it would be investors, and the definition then would become: âa strategic communication process that builds mutually beneficial relationships between organizations and their investorsâ; for employee relations, it would be employees, and the definition then would become âa strategic communication process that builds mutually beneficial relationships between organizations and their employeesâ; for donor relations, it would be donors, and the definition would then become âa strategic communication process that builds mutually beneficial relationships between organizations and their donorsâ; and so on.
Public relations and communication scholars may suggest the classic definition of public relations by Cutlip, Center, and Broom (2000): âPublic relations is a management function that establishes and maintains mutually beneficial relationships between an organization and the publics on whom its success or failure dependsâ (p. 5). Once again, the generic word âpublicsâ here can be replaced with the specific publics of individual specializations, such as investors. What is unique about this definition is that instead of word âcommunicationâ we see the word âmanagement.â It could be argued that one cannot build and maintain relationships based on communications aloneâactions are perhaps as important as words, or even more important. As a result, it is not enough to communicate; it is also important to act in a certain way, and for this investor relations professionals must have access to the top management of the organization and be able to influence the strategic direction of the company's development. This is why the word âmanagementâ replaced the word âcommunicationâ in this definition.
In the end, all of these definitions are correct in highlighting the importance of investor relations and financial communication for modern-day organizations. However, the NIRI's definition and the definitions of the PRSA and Cutlip et al. have very different final goals: the former talks about fair valuation of security and the latter talk about relationships. Laskin (2011) conducted a Delphi study of experts in the investor relations profession to find out what should be the final measure of investor relationsâ contribution to corporate value. Most of the experts rejected share price as a legitimate metric. In another study, ârespondents strongly rebuked ⌠the notion of using company share price as a valid measure of the success of investor relationsâ (Ragas, Laskin, & Brusch, 2014, p. 186). Instead of driving the share price, investor relations improves the availability and quality of information, helping investors and analysts to develop more reliable expectations about share prices, and this may be a better measure of investor relationsâ contribution.
Relationships, on the other hand, scored significantly higher among the experts. However, they were cautious about possibility of objectively measuring and evaluating the quality of relationships (Laskin, 2011). The same was also true in Ragas, Laskin, and Brush's study (2014). Experts highlighted that it may not be relationships per se that are significant but the expectations that they help to create, which make it easier to ignore temporarily blips in performance.
As a result, a definition of investor relations and financial communication may instead focus on expectations as the key outcome: Investor relations is a function of managing expectations. This managing of expectations is a two-way streetâinvestor relations professionals manage the expectations of investors and financial analysts about the company's past and future performance, but they also manage the expectations of the organization's executive team about the financial community's evaluation of the company and their reactions to the corporate news. The long-known equation of âreturn on equity,â then, is being transformed into âreturn on expectations,â and managing these expectations is becoming a key part of investor relations programs.
Efficient Market Hypothesis
The modern concept of investor relations is part of the efficient market hypothesis. The efficient market hypothesis is primarily associated with research by Fama (1970) and states: âA market in which prices always âfully reflectâ available information is called âefficientââ (p. 383). Such a market is in equilibrium: all securities are fairly priced, according to their risks and returns. No investors can consistently outperform, or beat, the market, and thus there is no reason to constantly buy and sell shares of companies in an attempt to outperform the average market return.
The efficient market hypothesis, however, requires key assumptions to be met: All relevant information about the company and its performance must be publicly available, all market participants must have equal access to such information on a timely basis, and all investors must be rational and capable of evaluating the information available to them. Fama (1965, 1970) talked about three levels of market efficiency: weak, semistrong, and strong. In the weak form of market efficiency, not all information is available to all market participants and, as a result, some investors can outperform others, taking advantage of better or faster access to information. In the semistrong form of efficiency, all public information is equally available to everyone and, as a result, already reflected in the stock price; however, there may be other, nonpublic, information that is not reflected in the stock price and, as a result, somebody with access to such information through, for example, insider trading can beat the market. And, finally, in the strong form of market efficiency, all information is reflected in the stock price and all investorsâinternal and externalâhave the same access to information and the same knowledge and understanding of the company.
Once again, investor relations, a function charged with providing information about a company to shareholders, financial analysts, and other market participants, is at the very foundation of the efficient market hypothesis. In fact, investor relations has become a key activity not just for particular companies but also for the whole modern economy. The sur...
